Overview of Finance:

What is Finance? Finance is defined as the management of money. A financial manager

includes the activities such as investing, borrowing, lending, budgeting, saving, and
forecasting. There are three main types of finance: (1) Personal Finance, (2) Corporate
Finance, and (3) public/government Finance.

What is Financial Management? Financial management mainly deals with the acquisition,
financing, and management of assets with some overall goal in mind. Thus the decision
function of financial management can be broken down into three major areas:

1. Investment Decisions: These decisions mainly deals with ‘how much assets are
required’ and ‘what should be the level of each asset’. For example how much cash is
needed, what will be the level of inventory, which machinery will be financially
feasible, and how much cash should be intact in marketable securities?
2. Financing Decisions: These decisions mainly deals with ‘how to finance the required
assets’. Or how much money we have to borrow and how much we have to invest
from the pocket of owner. These decisions also deals with dividend policy. How
much earnings we have to distribute to the shareholders.
3. Asset management decisions. These decisions deals with the efficient uses of the
acquired assets. Are we efficiently using the machinery? Are we efficiently managing
our inventory level? Are we effectively using our cash and marketable securities?

Consider a simplest format of balance sheet for the understanding of these decisions.

Current Assets: Current Liabilities:

Cash Account Payables
Account Receivables Accruals
Inventory Non-Current Liabilities:
Marketability securities Bank Loans
Non-Current Assets: Bonds
Furniture and fixture Equity:
Machinery Issued and Subscribed paid-up capital
Retained Earnings
Investment decisions deals with the assets side of balance sheet while Financing decisions
deals with the liabilities and equity side of the balance sheet. And Assets management
 decisions mainly deals with the management of current assets and current liabilities.
Assets management decisions also called working capital management decisions.

Objective of Finance: Objective of finance is to create value for the owners. Also called
value creation.

“Increasing shareholder value over time is the bottom line of every move we make”.

ROBERTO GOIZUETA; Former CEO, The Coca-Cola Company

Value maximization versus profit maximization: Objective of finance is value

maximization which may be maximized by maximization of profit. But always that is not true
because profit is the bottom line of income statement. Income statement is prepared on the
base of accrual accounting. To increase the bottom line impact sometime the preparer of
income statement manage earnings without the real improvement in operation of the
business. Sometime real improvement in net profit will also not a good indication due to
increase in risk which is the resultant of increase in profit, profitability can increase by
increasing debt burden and by taking more risky projects. If management continue these type
of activities then the some shareholders / owners will be dissatisfied from the management
and they will sell their shares. If these type of practices continued then the selling of shares
by many shareholders can put pressure and company may go bankrupt. This type of conflict
between shareholders and managers happen due to agency problem.

Agency Problem: To understand the agency problem firstly understand the principle agent
relationship. Agent: Individual authorized by another person, called the principal, to act on
the behalf of principle. Principle appoint the agent and pay perks and benefits to the agent
only if the agent achieve the objective of the principle. In our case shareholders / owners are
the principles and management play the role of agent. Agent has to perform the tasks which
are directed by the principle and ultimately provide benefits to the principle.

As we know perks and benefits of the management are associated with their performance and
to show the performance management can manage the net profits to maintain or increase their
perks and benefits. This conflict between owners and management is called Agency
Problem.

Corporate Social Responsibility (CSR):

Maximizing shareholder wealth does not mean that management should ignore corporate
social responsibility (CSR), such as protecting the consumer, paying fair wages to employees,
maintaining fair hiring practices and safe working conditions, supporting education, and
becoming involved in such environmental issues as clean air and water.

Corporate governance refers to the system by which corporations are managed and
controlled. It includes shareholders, board of directors, and senior management. Common
shareholders, who elect the board of directors; second, the company’s board of directors
themselves; and, third, the top executive officers led by the chief executive officer (CEO).

Role of the Board of Directors:

The board of directors sets company-wide policy and advises the CEO and other senior
executives, who manage the company’s day-to-day activities. In fact, one of the board’s most
important tasks is hiring, firing, and setting of compensation for the CEO.